Ben Bernanke's Exit Strategy Dilemma

The newly reappointed Fed Chairman Bernanke faces a dilemma of whether to keep interest rates low and risk inflation following the massive influx of money into the financial system or to increase interest rates and risk ending the economic recovery. Strong political pressure to create jobs and the currently tame inflation projections will favor the former as the likely choice. See the following post from The Capital Spectator.

Fed Chairman Ben Bernanke will be chatting up the central bank’s exit strategy later this week when he testifies before the House Financial Services Committee on February 10. To say that there are political and economic risks hovering over the subject is to understate the potential hazards.

There are risks to tightening too early, which some worry would repeat the mistakes of 1936-1937, when reserve requirements were tightened and the economy slipped into recession. At the same time, it'd be foolish to discount the potential for higher inflation in the years ahead in the wake of the extraordinary monetary stimulus over the past year or so. Regardless of the economic reality, the political pressure to keep rates low is intense, given the weak labor market.

In late-January, Carnegie Mellon Professor Alan Meltzer bluntly responded to Bernanke’s commentary on the details of an exit strategy by opining that the Fed chairman’s plan is destined to fail. Meltzer, author of a sweeping two-volume history of the Fed (A History of the Federal Reserve, Volume 1: 1913-1951 and A History of the Federal Reserve, Volume 2, 1970-1986), said that Bernanke's plan to prevent future inflation is "incomplete." As Meltzer explains, "The Fed recently began to pay interest to banks on the reserves they hold in their vaults. Using this new tool, it claims the ability to get banks to keep the money instead of lending it out, thus containing the money supply and inflation. I don't believe this will work, and no one else should."

Will Ben respond to the criticism and soothe Meltzer's concerns? Stay tuned. For the moment, however, the stakes are low, or so the market outlook for inflation suggests. The Treasury market's 10-year inflation forecast is a modest 2.27%, based on the spread between the nominal and inflation-indexed 10-year Treasuries as of Friday's close.

That's roughly in line with the inflation outlook just before all hell broke loose in September 2008, when Lehman Brothers failed and the financial troubles at the time exploded into a crisis. Among the fallout from the chain of events that month was the heightened risk of deflation. Judging by the market's forecast these days, the deflation risk has faded. Yet the inflation risk at the moment looks tame.

No wonder that the Fed funds futures market anticipates no imminent change in short term rates. If we look out a year, the futures market expects the Fed to raise interest rates, but just barely. The February 2011 contract is currently priced for a roughly 0.75% Fed funds. That's up from the current 0-0.25% target range, but as changes in rate expectations go, that's rather subdued.

Will Ben's testimony on Thursday give us reason to rethink the future of inflation and interest rates?

This post has been republished from James Picerno's blog, The Capital Spectator.

Job Market May Be Near Turning Point

John Lounsbury from The Street lays out the status of the jobs market which has moved closer to a crossover from job losses to job growth. However the extent of jobs lost since the peak in 2007 may be closer to 11 to 12 million when you take into account the average of 1.5 million jobs that would have been created under "average" economic conditions. See the following post from The Street.

The employment situation is clearly bad, but also improving.

The widely ballyhooed adjustment to past non-farms payroll numbers of 930,000 additional non-farm payroll jobs lost is much ado about nothing. This adjustment applies to the data for April 2008 through March 2009 and has nothing directly to do with such things as the unemployment rate calculation and total employment levels.

The U.S. Department of Labor (DOL) is correcting adjustments made for assumed new business formation. Bloomberg has published an estimate that another adjustment of nearly a million additional payroll job losses will be necessary in February 2011 for the 12 months which end next month. It is not clear if this estimate is still valid.

The DOL just announced new adjustments to the birth/death model for estimating business creation/closings that were applied this month for the first nine months of the current period. These adjustments for April through December 2009 total 434,000 additional payroll job losses.

Glimmers of Hope for Employment

The unemployment data is mixed, but previously reported glimmers of hope are still there this month. A brief summary of the mixed data would include (with details to follow):

Positive Factors

1. The official unemployment rate has improved from 10.1% in October to 9.7% in January. This is not a significantly significant change due to +/- 300,000 sampling error uncertainty in the DOL data, but the rate has remained below the October peak for three months now, which is significant.

2. Temporary employment is up 247,000 from a low in September. Using more temps often precedes adding permanent new positions.

3. Manufacturing jobs increased by 11,000. This is associated with inventory building.

4. The average work week increased to 33.3 hours for production workers. The low was 33.0 hours last seen in October.

5. Average overtime hours for manufacturing workers was 3.5 hours per week. This is an increase of 26% from the low of 2.6 hours in March 2009.

6. Part-time for economic reasons ("forced" part-time) declined by 10% from 9.2 million to 8.3 million. Most of this change was in the category of decreased slack in business conditions for existing employees. The number who could only find part part-time work was unchanged at 2.3 million.

7. The weekly initial unemployment claims are still tracking the curve for a normal jobs recovery.

Negative Factors

1. Government employment decreased by 8,000 in January, despite a surge in Census Bureau temporary hiring. State and local payrolls decreased by 41,000.

2. Non-farm payrolls continue to decline, although at a low rate.

3. The unemployment rate remains high.

4. The shortfall in employment remains at historic levels, between 11 and 12 million below what would be expected for an economy experiencing the average job growth seen from 1999 to 2007.

5. The four-week moving average of weekly initial unemployment claims has increased by 6.4% over the past three weeks.

6. We are missing 2.8 million people from the civilian labor force over the past nine months.

7. Permanent job losses and historic levels in duration of unemployment are still burdens.

Unemployment

Employment peaked at 146.7 million in November 2007. In December 2009 it had declined to 137.8 million. January saw an increase of 541,000 to 138.3 million. That is a decline in employment of 8.9 million as of December before rebounding to a loss of 8.4 million in January. All numbers are seasonally adjusted.

The not seasonally adjusted data produced a loss of 1.1 million jobs from December to January and 10.3 million jobs since November 2007. Lots of people talk about seven million jobs lost in this recession, but they are not using the official numbers from the U.S. Dept. of Labor.

However 8.4 million job losses is only part of the story. For the years 1999 through 2007, an average of more than 1.5 million were added to the employment rolls each year. This average includes two years with employment growth in the 300,000 range and one year (2001) with a loss of 1.5 million, so it is a representative (not inflated) average.

That means that employment should have grown by 3 million during this time if we had "average" economic conditions rather than recession. That puts the effective increase in unemployment between 11 and 12 million compared to what it would have been in an average economy.

The Declining Labor Force

The civilian labor force has declined by 1.8 million from a peak in March 2009 of 155.0 million to 153.2 million in January 2010. Some have suggested that this might be due to a decline in illegal immigrants, but that is unlikely because the labor force identified as Hispanic or Latino has increased by 400,000 from 22.2 million in March 2009 to 22.6 million for January.

The decline of 1.8 million in the civilian labor force is not the whole story, because from 1999 through 2007 the labor force grew by an average of 1.5 million a year. That includes two years (2001 and 2002) during the previous recession that had an average increase per year under a million.

Normally we would have expected an increase of the order of a million from March 2009 until now. That puts the labor force shrinkage at something at least as large as 2.8 million in nine months. This is unprecedented in recorded history, as shown in the following graph



Rising Weekly Initial Unemployment Claims

The four-week moving average for weekly initial unemployment claims for the third week in a row. On Jan. 9, it was 440,750 and 468,750 in the latest report for Jan. 30. That is a non trivial increase of 6.4%. As reported last week here, this rise remains well within the parameters of unemployment claims in previous recoveries.

However, if we get another 5% increase in weekly initial jobless claims in the coming weeks, the current unemployment behavior will move out of the range of the well behaved employment recoveries and into the realm of the jobless recoveries of the recessions ending in 1970, 1991 and 2001.

When Will We Start Gaining Jobs?

The rate of change indicated by four-month moving averages now projects that we will cross the zero line for employment growth in the first quarter, as shown in the following graph. This is an improvement from a projections made in previous months that the crossover to employment growth would occur in the second or third quarter.





While the number of employed may start to grow, the unemployment rate may not improve significantly in 2010. As the 2.8 million people now missing return to the labor force, plus the additional 1.5 million new workers statistically expected to be added per year, the first four million added to employment will be largely offset in calculating the unemployment rate.

The situation will have to improve for a long time before the unemployment rate drops from the vicinity of 10%.

For investors, as employment increases, more money will be earned for consumption and that will support GDP and help such sectors as consumer staples and food and recreation.

The broad market should also gather support if employment starts growing at 100,000 a month or more.

This post has been republished from The Street.

Many Baby Boomers Finding Stocks Too Risky

With many baby boomers having lost significant wealth in the stock market during recent crashes, many are losing faith in stocks and switching to other investment vehicles. However, with lifespans increasing, there is concern that low yield investments like certificates of deposits or bonds may not provide enough growth for an ideal retirement. See the following post from The Mess That Greenspan Made.

The newspapers are full of stories about how baby boomers who have squirreled money away are rethinking their investment approach, evidence coming from last year's net outflows from stock funds and the fascination that many retail investors now have with bonds.

With the combination of an increasingly "risk averse" baby boomer crowd that is rapidly approaching what they once thought was retirement age and after multiple collapsing asset bubbles seen over the past decade, you'd have to think that investing for retirement is now undergoing some fundamental changes - and these aren't the kind of changes that the folks on Wall Street will probably like.

A number of stories over the last few days have helped to make this point, starting with a USA Today report in which the lead interview subject makes it quite clear that he's had enough.

Near the stock market low last spring, with his losses nearing $200,000, Martin Blank, 67, a Florida retiree with four decades of investing experience, sold most of his stocks.

He liquidated 75% of his stock funds. He hasn't put that cash back in the market. And doesn't plan to.

That emotion-driven decision, made with his wife, Linda, nixed any chance of profiting from the 63% rally that began shortly after selling out in a state of anxiety.

But Blank has no regrets: "I have no desire to attempt to make back what I lost."

Forty years of investing and that's it - it's hard to blame Martin for his decision, but it's equally hard to understand how investing as we've come to know it since the mid-1980s can continue.

Recall that it was back in 1984 that 401ks were first introduced in the U.S. and ordinary folks were first given a modest amount of control over how their retirement money was invested. That morphed into near complete control years later and this all worked quite well up until the bull market in stocks ended in 2000.

The Christian Science Monitor looked at how prepared the baby boomer crowd is for retirement in this story and came away unconvinced that the "golden years" will be very pleasant for many.

The leading edge of the baby boomers – the postwar generation that led the way on everything from war protests to yuppiedom and two-income families – is about to experience another first: postcrash retirement.

With the first wave of boomers turning 64 this year, they have little time to make up their losses from the recent debacle of stocks and housing. Not since the late 1930s have workers on the cusp of retirement faced such a big one-two punch.

So how are they handling it? Not well. It's almost become a cliché to say most boomers haven't saved enough for retirement. Nearly a quarter of those who turn 50 this year say they haven't even started saving, according to a poll in January. Here's the surprising part: According to some experts, even those who have managed to stash away some savings must be careful not to invest the money too cautiously.

With life spans increasing – and many boomers dreaming of active retirements, among other factors – some advisers suggest that near-retirees keep a sizable holding in stocks. The old adage – subtracting one's age from 100 to get the proper stock allocation – just doesn't apply anymore, this camp believes.

I don't know about you, but this whole "double-down" thinking by investment advisors seems fraught with risk. Sure, doubling down last spring would have been a great idea, but there are probably a lot more investors like Martin Blank in that first story above than there are those who have the stomach to "buy when there's blood in the streets".

Even Jason Zweig in this piece from the weekend issue of the Wall Street Journal seems a little down on the whole idea of people navigating the years ahead using what has passed for conventional wisdom when it comes to investing.

For many investors, the market's turbulence hasn't just destroyed wealth. It has shattered their faith in the financial system itself.

Consider Philip Eberlin, 56 years old, who runs a woodwork-restoration business in Chicago Heights, Ill. Trading hot stocks a decade ago, Mr. Eberlin got burned on picks like Krispy Kreme and Tyco. In 2007 he got back into stocks, only to take another hit.

"Having been burned twice in 10 years," says Mr. Eberlin, he now has about 80% of his family's assets "protected from the market" in certificates of deposit and fixed annuities. "I don't have trust in Wall Street to help the small investor in any way, shape or form."

Mr. Eberlin isn't alone. Late last year, Decision Research of Eugene, Ore., asked Americans how much they trusted bankers and other Wall Street leaders "to reduce the risk of the financial challenges the country is facing now." On a scale of 1 to 5, with 1 meaning no trust at all, the rating averaged a paltry 1.7.

Where do you go from here?

On the one hand, it's great that people have the amount of control that they have over their own retirement planning but, on the other hand, retirement dreams are now fading fast for millions of Americans and we've probably got at least a few more years before this secular bull market in stocks is over.

If only more people had sold their stocks ten years ago and bought gold, there would be far more happy retirement stories today.

This post was republished from Tim Iacono's blog, The Mess That Greenspan Made.

Gold's Next Bull Run May Be Just Around The Corner

With gold falling recently, there may have been a fall in enthusiasm for gold but the fundamentals are still in place. With the Fed's policies unchanged and the threat of some nations defaulting on their debt, the possibility of a strong bull market may be just around the corner. See the following post from Expected Returns.

After a 15% correction in gold and a 40% correction in many miners, most latecomers to the gold bull market now know that investing in gold is not easy! These are the kind of corrections that really test the conviction of gold bugs; I wonder how many will still be around when the next leg up in this bull market begins.

In any bull market, corrections of this kind are the norm, yet investors get so caught up in the daily swings that they end up selling at precisely the point that would have yielded them maximum profits. In other words, they sell at the bottom. The healthy correction in gold stocks should have long-term gold bulls celebrating on the streets, yet many are at maximum levels of despair. I suspect many latecomers to the gold party have finally capitulated and are swearing off investing in gold forever- that is, until we put in the next intermediate term top, at which point, they will be buyers again. The increasing bearish sentiment gold is a bullish sign and very conducive to the next leg up.

Be patient- this bull market has years to go.

Technical levels of interest

Now that gold has broken down below the multi-month consolidation zone, I would be looking for gold to consolidate between $1,040 and $1,050 dollars. Look for a possible retest of the breakout level of $1,025 dollars. The 200- day moving average is still firmly moving up, and this will serve as another level of support moving forward.



Fundamentals, Fundamentals, Fundamentals

What in the fundamental picture of gold has changed in the past 2 months? Has our government decided to rein in their spending? Has Helicopter Ben Bernanke stepped down yet? Have central banks become net sellers of gold? Has mine production risen substantively, altering the supply/demand dynamic?

The answer to all these questions is no. The fundamentals in gold are still in place, and are in fact, stronger than they were months ago. With rising volatility and threats of sovereign defaults looming everywhere, there will be a mass flight to quality, which means gold. Right now, gold is selling off along with every other asset class besides bonds. This is a miscalculation by the market. However, it usually takes the market some time to sort out short-terms mistakes caused by the raw human emotion of investors. Do you remember the massive rally in gold shares that followed the broad sell-off in stocks in the Fall of '08? Well these are the kind of severe oversold conditions we are starting to see now in the gold space.

That being said, I am still very bullish on gold in the long run. All corrections should be used as buying opportunities.

This post has been republished from Moses Kim's blog, Expected Returns.

China's Trade Practices: A Barrier To Job Growth

Peter Morici discusses one of the barriers to job growth, which is the enormous trade deficit with China due to huge tariffs, administrative barriers, and undervalued currency. Without taking action against China's trade practices, unemployment will remain high. See the following post from The Street.

President Obama is seeking to double U.S. exports and create 2 million jobs over the next five years. The new Commerce Department program to accomplish this goal is simply inadequate.

The Commerce Department initiative merely consists of redoubling existing efforts and not addressing the fundamental issues -- the undervalued Chinese yuan and high tariffs and other regulatory barriers that block U.S. exports in much of Asia.

Commerce Secretary Gary Locke is launching a program by increasing Export-Import Bank funding for small businesses from $4 billion to $6 billion; boosting Commerce Department personnel that assist exporters at U.S. embassies and consulates in China and India; and strengthening enforcement of trade laws and agreements.

Of course, these initiatives are helpful and could increase net exports by several billion dollars; however, those will not double exports, which now total $1.7 trillion or appreciably reduce a trade deficit of $440 billion caused by $2.1 trillion in imports. The trade deficit is likely to grow in 2010 and drag on the economic recovery.

The administration is correct to target China and India, but these initiatives don't address the reasons U.S. businesses don't sell enough in those countries.

China is the larger and faster-growing market and maintains an undervalued currency that makes Chinese products artificially cheap, whether at the Wal-Mart(WMT Quote) or competing with U.S. exports in China. It imposes huge tariffs and administrative barriers to U.S. exports. Conditions are not much better in India.

China exports about $330 billion to the U.S. but purchases only about $88 billion. Without a revaluation in the yuan large enough to end China's persistent purchases of U.S. dollars, the bilateral deficit is simply not coming down.

The president says he will try to persuade China to revalue its currency, but the diplomatic efforts by the Bush administration wholly failed to significantly alter China's policies.

Without strong U.S. action to offset China's currency market intervention, which exceeds $400 billion a year, China simply is not going to change its currency and trade policies, and U.S. unemployment will stay close to 10% or higher.

Taxing dollar-yuan conversion to offset China's currency subsidies would level the playing field, but the administration has offered no substantial proposals that promise to level the terms of competition for U.S. businesses in China or inspire a change in China's protectionist policies.

This post was republished from The Street.

Strategic Defaults Expected To Rise In 2010

Another stumbling block for the housing market this year may be homeowners who are able to pay their mortgages but choose not to because their home is so far underwater. With over 5 million mortgage holders projected to be significantly underwater by June, strategic defaults will be on the rise. See the following post from Expected Returns.

From the New York Times, No Relief in Sight, More Homeowners Walk Away:

New research suggests that when a home’s value falls below 75 percent of the amount owed on the mortgage, the owner starts to think hard about walking away, even if he or she has the money to keep paying.

In a situation without precedent in the modern era, millions of Americans are in this bleak position. Whether, or how, to help them is one of the biggest questions the Obama administration confronts as it seeks a housing policy that would contribute to the economic recovery.

The number of Americans who owed more than their homes were worth was virtually nil when the real estate collapse began in mid-2006, but by the third quarter of 2009, an estimated 4.5 million homeowners had reached the critical threshold, with their home’s value dropping below 75 percent of the mortgage balance.

They are stretched, aggrieved and restless. With figures released last week showing that the real estate market was stalling again, their numbers are now projected to climb to a peak of 5.1 million by June — about 10 percent of all Americans with mortgages

Introducing the strategic default- yet another factor that will weigh down on housing. The only thing that can prevent a trickle of foreclosures turning into a flood is an immediate V-shaped rally in home prices, since time is the enemy of underwater homeowners, especially with rising carrying costs. However, even if consumers are willing to step in and buy homes, banks are still wary of extending credit.

The estimated 5.1 million homeowners with home values below 75% of mortgage values, or 1 in 8 homeowners, will eventually capitulate. With over 15 million Americans (and rising) currently unemployed how will housing recover? Watch for mortgage resets in upcoming months to provide the knockout punch for many homeowners and effectively negate the influence of tax-credits on home prices.

"We’re now at the point of maximum vulnerability,” said Sam Khater, a senior economist with First American CoreLogic, the firm that conducted the recent research. “People’s emotional attachment to their property is melting into the air.”

The difference between letting your house go to foreclosure because you are out of money and purposefully defaulting on a mortgage to save money can be murky. But a growing body of research indicates that significant numbers of borrowers are declining to live under what some waggishly call “house arrest.”

Using credit bureau data, consultants at Oliver Wyman calculated how many borrowers went straight from being current on their mortgage to default, rather than making spotty payments. They also weeded out owners having trouble paying other bills. Their estimate was that about 17 percent of owners defaulting in 2008, or 588,000 people, chose that option as a strategic calculation.

Evidence continues to mount that national home prices will fall in 2010. Too many people are jumping directly into the fire and buying homes, not realizing the tenuous state many homeowners are in, while ignoring tremendous overhang of shadow inventory- which will put a lid on any housing recovery.

This article has been republished from Moses Kim's blog, Expected Returns.

The Worst Of The Recession Is Behind Us

Steve Sjuggerud from Daily Wealth believes that the worst of the recession is behind us based on a comparison of previous financial crises in the history of the United States. Stocks and housing have already fallen more than historic averages and have already been recovering for months. See the following post from Daily Wealth.

We're out of the woods with this financial crisis...

That's my best guess at least, based on a study of the major financial crises through history.

The recent book This Time is Different: Eight Centuries of Financial Folly, by Kenneth Rogoff and Carmen Reinhart, takes a look at the history of major financial crises...

Boiling the book down to its simplest conclusions, here's what happens after a banking crisis:

• Home prices and stock prices collapse dramatically over the course of several years.

• The economy tanks and unemployment rises dramatically.

• Government debts soar.

The book gives specific timelines based on history... It tells us how far things fall and how long these things last. And it gives us a pretty good idea of what to expect going forward.

Let's look at a few of their conclusions more specifically, starting with stocks...

Stock Prices

The authors found that real stock prices typically fall 56% over three and a half years, on average. In the current financial crisis, stocks already fell a bit more than that, in a much shorter period of time, bottoming in March 2009. Then they rallied dramatically.

Is the worst over in stocks? Or is another leg down coming?

I personally believe the worst is over.

At first, the crisis blindsided us, so the effect was dramatic. Now we're aware... more sober... So I think the lows we saw in March 2009 will be the ultimate lows for this crisis in stocks.

Home Prices

The authors found real home prices typically fall 35% over six years. This time around, home prices (like stocks) fell a bit more than the authors' average in a much shorter period of time.

Like stock prices, home prices have been recovering.

Is the worst over? Or did the recent home-buyer tax credit prop prices up?

I think the worst is over. I think we've seen the lows. But home prices may do basically nothing for many years.

Unemployment

According to the authors, unemployment typically rises by seven percentage points in a banking crisis... and unemployment stays "bad" for four years. So far, unemployment has risen by about five percentage points, and we're two years into this thing. So if the authors are right, unemployment could hit 12% and last two more years.

Government Debt

The authors state that government debt explodes by 86% above pre-crisis levels, on average. In the current crisis, quite frankly, I have no idea how much government debt has REALLY exploded. Nobody can know that answer... with all the creative things going on at the Federal Reserve and the Treasury Department.

So where does that leave us?

This crisis has been worse in magnitude than most, according to the authors' numbers. It's also been devastatingly quick.

The good news here is that we may already be out of the woods... Stock prices and home prices have been recovering for months. And unemployment has leveled off in the 10% range.

The bad news is the government's explosion in debts. But risks associated with that won't likely come home to roost in the next couple of years. That's a topic for another day.

In short, based on past crises, it's easy to make an optimistic case that the worst is behind us in the economy.

This post has been republished from Steve Sjuggerud's Daily Wealth.

Bernanke Officially Sworn In For Four More Years

Despite unprecedented resistance, the publicly unpopular Ben Bernake was officially reappointed as Chairman of the Federal Reserve for another four years. Bernanke spoke about the Fed becoming more transparent and maintaining independence. See the following post from The Mess That Greenspan Made.

Ben Shalom Bernanke, Time Magazine's "Person of the Year", was sworn in for another four-year term as Chairman of the Federal Reserve a short time ago in a subdued affair that had none of the pomp and circumstance of four years ago.

Instead of a crowd that included President Bush, one cabinet member, two former Federal Reserve chairmen, and members of Congress, today's ceremony was a staff-only gathering where the only one in attendance not on the Fed payroll was Bernanke's wife Anna and the event barely made the news.

Of course, the lack of fanfare likely has something to do with the fact that the central bank chief remains quite unpopular in the public's eye, many likening his role in the financial crisis to that of Captain Smith of the Titanic who failed to see the iceberg ahead but was largely successful in getting as many passengers into lifeboats as possible.

The critical distinction between Smith and Bernanke was that the 2008-2009 financial lifeboats had a disproportionate number of Wall Street bankers and the Captain did not go down with the ship.

Fed Vice Chairman Donald Kohn administered the oath today in the atrium of the Federal Reserve building in Washington D.C. after which Bernanke delivered another speech in which he stressed the need for both independence and openness for the central bank - a mixture that some see as opposing goals.

The Federal Reserve has been granted, both in law and in political tradition, considerable independence and autonomy. That independence serves important public objectives. Critically, it allows the Federal Open Market Committee to make monetary policy in the longer-term economic interests of the American people, rather than in the service of short-term political imperatives. It also allows the Federal Reserve to make supervisory decisions based on the facts of each case and the need to preserve financial stability, not on the basis of political considerations. In the interest of maintaining public confidence and promoting economic and financial stability, we must continue to protect our independence.

At the same time, in a democratic society like our own, institutional independence brings with it fundamental obligations of transparency, responsiveness, and accountability. The Federal Reserve is already one of the most transparent and accountable central banks in the world, providing voluminous information and explanation concerning all of its activities. However, I believe that we should be prepared to do even more, to become even more transparent. It is essential that the public have the information it needs to understand and be assured of the integrity of all our operations, including all aspects of our balance sheet and our financial controls. We will continue to work with the Congress to ensure maximum transparency of America's central bank, without compromising our ability to conduct policy in the public interest.

If they're so transparent why are they getting sued all the time and, as for independence, surely, in this case, it is overrated - it's hard to imagine how, over the last 20 years, we'd be any worse off today if Congress was running the central bank.

How could they have done any worse than the combination of former Fed chairman Alan Greenspan and his protege Ben Bernanke?

Thanks to cheap imports and the neutering of the consumer price index over the years, inflation would never have been a major problem no matter who was setting interest rates and, after years of tough love from Volcker in the 1980s, the nation was primed to create jobs.

Now, about all we can hope for is another asset bubble to come along and make us all feel rich again for a few years before the inevitable bust.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Federal Housing Administration Facing Trouble As Foreclosures Rise

The Federal Housing Administration may have to tap into tax payer money for the first time in its history as foreclosures on FHA loans continue to mount. Foreclosures are expected to continue to increase and housing prices may shrink as stimulus measures expire. See the following post from Expected Returns.

From the Washington Post, Rising FHA default rate foreshadows a crush of foreclosures:

The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market's recovery.

About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency's figures show.

Although the FHA's default rate has been climbing for months and eating into the agency's cash, the latest figures show that the FHA's woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008. Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made.

If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses -- a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

There is little doubt in my mind that foreclosure will rise in 2010. FHA backed loans are just one of the mechanisms by which the government is artificially supporting the housing market. While government-sponsored stimulus temporarily creates an artificial boom, sooner or later the free market dictates where prices will go. Watch for asset prices to tanks as stimulus programs expire one by one.

Souring FHA-Sponsored Loans

For now, just about every major measure of the agency's financial health is worsening.

The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47 percent more loans in October and November than in the corresponding period a year earlier, according to an FHA report.

The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26 percent in the last quarter from a year earlier.

FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency's troubles with the 2007 and 2008 loans in October, when he told a House panel that "rogue players on the margin" immediately migrated to the world of FHA lending after the subprime mortgage market collapsed.

Although lending standard for FHA-backed loans have improved recently. there is no question that the FHA has served as the "lender of last resort" for a multitude of potential homeowners. The effect of these irresponsible loans are just starting to be felt. 2010 will be the beginning of a slow grind down in housing that will be measured in years.

Projections of brighter economic conditions are based on presumptions and blind hopes of a recovery in housing that are unlikely. Remember, foreclosures aren't isolated events, as they negatively effect surrounding home prices. To put it simply, rising foreclosures and rising unemployment are not what recoveries are founded on. There is no recovery.

This post has been republished from Moses Kim's blog, Expected Returns.

Consumer Spending Shows No Signs Of Life

While we don't know whether monetary policies, fiscal stimulus, or the natural business cycle are the main cause of the rebound in GDP growth, we do know it is probably not consumer spending which has stayed relatively flat. The changing of spending habits and lack of job market improvement are keeping consumer spending growth at early recession levels. See the following post from The Capital Spectator.

The December update on personal income and spending isn’t terribly informative. Disposable personal income rose 0.4% in December, modestly above the monthly average rise during 2009 (0.3%). Meanwhile, personal consumption expenditures increased 0.2% in December, or slightly below average based on the monthly average for last year (0.3%). It all rounds out to a yawn in terms of what one month's numbers tell us. Par for the course.

Still, it’s a bit unnerving to learn that the pace of consumer spending growth in December is down substantially from the 0.6% and 0.7% levels for October and November, respectively. But that’s not terribly surprising, given the ongoing contraction in the labor market. Meantime, there's the general recognition that Joe Sixpack needs to save more than he has been doing over the past generation. That's not exactly an encouraging prescription for what ails the economy at the moment. But it is what it is. Balancing long-term needs with short-term fixes, it seems, is the general dilemma that await, and no one really has a persuasive solution.

As for the statistic du jour, if we step back and look at the 12-month rolling change in personal income and spending, it appears that we’ve reached a critical point. As our chart below shows, the annual pace of change for income and spending has nearly returned to the levels that prevailed just before the onset of the recession in December 2007. There’s some debate as to how much of this rebound is due the liquidity injections of monetary policy vs. stimuluative fiscal policy vs. the natural recovery process endemic in the business cycle. Meantime, the pressing issue is whether the bounce in spending and income will continue to climb or at least remain stable at current levels.



Ultimately, the answer resides with the labor market. The next installment of insight on the jobs front arrives this Friday, when the update on nonfarm payrolls is released. From our vantage, the stakes look unusually high (even by recent standards) on the news of whether the labor market is growing or not. If nonfarm payrolls can’t at least show a small net increase at this point, well, let’s not even go there...yet. Suffice to repeat what we said about the trend in nonfarm payrolls: the hour is late.

This post has been republished from James Picerno's blog, The Capital Spectator.